Why MPC is likely to keep repo rate unchanged in this review

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Jun 04, 2018, 07.27 PM IST

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By Aditi Nayar

Year-on-year (YoY) CPI inflation prints, released since the April 2018 money policy review, have thrown up a mixed trend, with inflation easing from 4.4 per cent in February 2018 to 4.3 per cent in March 2018, and then reversing to 4.6 per cent in April 2018. Additionally, core CPI inflation hardened to a 44-month high of 5.9 per cent in April, 2018.

Some of the risks highlighted by the Monetary Policy Committee (MPC) in the April 2018 policy review have come to the forefront, particularly the surge in global crude oil prices, accompanied by a weakening of the Indian rupee.

However, the momentum of the seasonal rise in food prices continues to be weakened by items such as sugar, pulses and onions. Additionally, greater clarity is awaited on various factors, which can influence the inflation trajectory going forward, such as the level of minimum support prices (MSPs) for kharif crops, and the volume and dispersion of monsoon rainfall in 2018.

The decline in CPI inflation from 4.5 per cent in FY2017 to 3.6 per cent in FY2018 was accompanied by one rate cut in 2017. While monthly CPI inflation prints are likely to remain volatile going forward, we expect average CPI inflation to rebound to 4.6 per cent in FY2019. This, in conjunction with the higher-than-anticipated GDP expansion in Q4 of FY2018, suggests an imminent rate hike in H2 of CY2018.

However, we expect a limited likelihood of monetary tightening this policy review, as lack of clarity on the aforesaid factors such as monsoon, MSPs as well as fiscal risks is likely to generate varied responses from the MPC members.

While a decision to leave the repo rate unchanged at 6 per cent is likely to be non-unanimous this time around, the tone of the policy document is likely to signal that a withdrawal of accommodation and a rate hike would be forthcoming.

Domestic bond yields have hardened considerably in recent months, in line with global trends, the decline in systemic liquidity surplus and a rise in fiscal and inflationary risks. In addition to this, the eventual monetary tightening in 2018 may push up bank lending rates, suggesting that interest costs are likely to rise this financial year.

We expect RBI to reiterate its stance of maintaining systemic liquidity closer to neutrality in the forthcoming policy review. RBI conducted an open market operation (OMO) to purchase Rs 100 billion of G-sec on May 17, 2018. Given the moderation in liquidity surplus and India’s foreign exchange reserves, FII outflows and depreciation in the rupee, we expect OMO purchases by RBI to range between Rs 600-1,000 billion in FY2019. This should help dampen bond yields to some extent, even if the repo rate is eventually hiked by the MPC in the second half of CY2018.

(Aditi Nayar is Principal Economist, ICRA)

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